In 2000, supranationals and agencies raised just under $40bn in the dollar market. Nine years later volumes reached $216bn, according to data provider Dealogic. While 2010 was slightly lower as the European sovereign crisis hit issuance, 2011 looks set to be another record year, with more than $53bn already raised in the first three months.
This was beyond what many market participants had expected after a cautious end to 2010 when the European sovereign crisis put a lid on issuance.
"January 2011 was a record month for the SSA market and for dollars in particular," says Sean Taor, global head of public sector debt capital market at RBC CM in London. "The sell-off in US Treasuries, which began at the end of last year and has continued into 2011, has been one of the main drivers behind demand. While 10 year US Treasuries were trading at a low of 2.38% in early October, they have backed up to 3.73%. The fact that the European sovereign situation stabilised in early December has taken away some of the uncertainty that has plagued the sector and led to a more stable issuance backdrop."
Appetite for dollar issues from supranational and agencies has appeared inexhaustible so far in 2011. In the week of January 21, $16.5bn of supply was easily absorbed despite the hectic pace since the beginning of the year. A $5bn five year issue for the World Bank attracted $7bn of orders.
Almost a month later and the pace showed no sign of slacking. In the week of February 11, $12bn of supply was again easily absorbed despite fears at the time that investors might be overwhelmed by the sheer amount of primary supply.
"The third wave of issuance could not have come at a better time," says Stuart McGregor, head of EMEA public sector DCM at Bank of America Merrill Lynch. "It followed a quiet time during the Chinese New Year and a pop up in yields which meant that the rollercoaster could happen again. As a result the first few weeks of 2011 have been fantastic for issuers in terms of liquidity and market access."
For some larger issuers, this has meant that they have been able to execute a good share of their funding requirements. Klaus-Peter Eitel, vice president in capital markets funding at KfW in Frankfurt, says his agency had already done $9bn under its dollar global funding programme by mid-March. Overall, it needs to raise Eu75bn equivalent in the markets this year.
"One reason why there has been such a strong investor demand in dollars has been the wave of redemptions from older bonds coming due in large sizes. As a result, this cash has got to be redeployed. Furthermore, increased central bank reserves mean that a lot of cash needs to be invested."
This story will be very familiar to many in 2011 and demonstrates how important the dollar market has become over the years, in particular for those issuers with large funding needs.
But while for the large supras and agencies like KfW or the European Investment Bank (EIB) it is expected that a substantial proportion of their funding should be done in dollars, the popularity of the dollar market has also been evident with the smaller agencies and supranationals.
"While a number of issuers have been focused on the global dollar market for some time, we are starting to see more borrowers who used to issue in Eurodollar format develop Reg S/144A or SEC-registered programmes as they seek to access the deep liquidity in the US market," says Jeff Diehl, global head of public sector origination at HSBC.
"Meanwhile, if you look at issuers such as EIB and KfW, dollars have made up a larger proportion of funding over the last couple of years."
The importance of the 144A format among European agencies is undeniable. Bank Nederlandse Gementeen (BNG), Network Rail, and Kommunalbanken are among those to have put such programmes in place, while Caisse dAmortissement de la Dette Sociale (Cades, NRW.Bank, Nederlandse Waterschapsbank and Municipality Finance are considering the format.
"Issuers have set up 144A programmes to access the domestic US investor base," says Guy Reid, head of SSA DCM, EMEA, at UBS. "This expands an issuers investor base and also reduces execution risk should there be lower demand outside the US. As the US dollar market remains the most cost-effective market for volume, issuers are keen to maximise issue sizes in this market. The bid from US investors tends to be at a wider level than that from non-US investors, particularly official institutions. During the financial crisis, SSA dollar spreads widened to a level where there was substantial US demand for the asset class."
Reid adds that those issuers without global issuance programmes or 144A documentation were unable to take advantage of this demand during the crisis.
At the beginning of January, Network Rail priced its largest ever dollar deal, a $1.5bn three year of which 38% was sold into the US.
In October last year, BNG priced a $1.5bn five year trade which attracted $2bn of demand and of which 46% was sold to US investors.
"It was an expensive exercise to integrate 144A and, given the low yield environment, we were concerned about how much we would sell into the US," Bart van Dooren, head of funding and investor relations at BNG said at the time.
"Getting 46% US placement, which is not inflated by supras or bank treasuries, was a very pleasing result for our inaugural 144A transaction."
The two issuers are examples of how strategically supras and agencies view the dollar market and how over the last few years it has become less of an arbitrage market for many.
"Over the last two years, more and more European agencies which had looked at this market opportunistically have started to embrace it more strategically," says RBCs Taor. "They are doing more roadshows, and many are moving to the 144A format. The fact that you are seeing BNG and Cades, for example, embracing the format is not just because the cost of funding is so good but because the investor base is getting deeper and they understand these credits better."
Deep liquidity pool
The depth of the investor base has been one of the long lasting appeals of the dollar market. The currency remains the core holding for central banks across the world and the US domestic investor base is one of the largest in the world.
"The demand side of the dollar market is also what has been making it very attractive for borrowers," says HSBCs Diehl. "Expectations are that the GSE market is going to shrink over time and that supras and agencies should benefit from this. This, added to the number of redemptions coming up from issuers like SFEF and other government guaranteed issuers, means that there is a lot of liquidity in the market. Lastly, central banks are a very important component and the dollar remains the major reserve currency."
A number of central banks that were constrained by the crisis are back online, he adds, and high commodity prices, especially the elevated price of oil, are creating more cash for a number of them to invest.
However, while central banks appear to be back in the buying driving seat, the US domestic investor base can be hard to tap into.
"In 2010, we saw US participation in some US dollar SSA deals approach 40% plus," says Anthony Demartino, global co-head of US and European SSA trading at UBS. "Unfortunately the breadth of US accounts did not grow substantially. As spreads between the GSEs and SSA paper narrowed, the ability to attract new US investors became increasingly difficult. When the sovereign debt crisis hit, it only got tougher. Before the crisis, triple-A was simple to understand, post-crisis, there is heightened credit scrutiny from investors."
Demartino adds that for some investors, having to understand these issuers and where the guarantees lie is just too much work, especially when the pick-up to GSE debt is minimal.
The drop in GSE issuance has been sharp and is likely to continue to be so as the US government winds down the agencies. While in 2010 they raised $1.2tr, which was far above the $860bn they raised in 2008, this number will be less this year as the GSEs are forced to shrink their portfolio by 10% a year.
In the first quarter of 2011, the GSEs have done $132bn versus $221bn for the same period last year.
But as Demartino points out, the drop in GSE issuance does not necessarily mean a like-for-like pick up in demand for supras and agencies. "We have not seen an uplift in demand as a result of the drop in GSE issuance," says Sandeep Dhawan, head of dollar funding at the EIB in Luxembourg. "In the long run, you could theoretically argue, that with a very large volume of high grade issuance disappearing, existing similar product from SSA issuers would tend to fill the gap in investors portfolios. However, our experience suggests that such a one-for-one substitution does not correspond to reality."
Greg Arkus, head of public sector debt at Credit Suisse, echoes this view. "With US agency supply dwindling, expectations had been that more appetite would come through from US investors but it has not been as substantial as first anticipated," he says. "However, we expect that to develop over time. One of the issues with US accounts is that they have a broader mandate and look at a range of asset classes to assess relative value, whereas EMEA investors tend to focus more specifically on SSA credits."
But the development of the dollar investor base over the years has meant that it is not just a central bank or US-based one anymore, as BofA Merrills McGregor points out. "Issuers are no longer relying on one investor base, or one geography, to get a dollar deal done," he says. "Because demand is fairly split, it has made market access very stable."
While investors with deep pockets have clearly been an attraction for issuers, that the dollar market can provide an avenue for funding when the euro market is busy is another reason why dollars are so popular with supras and agencies.
With the birth of many new agencies as a result of the crisis, the euro market can look very crowded at times. In Spain, as well as Ico, Fade and Frob have been created. In Germany, FMS Wertmanagement, Hypo Real Estates bad bank, and Erste Abwicklungsanstalt, WestLBs bad bank, are also soon going to be busy as they have big asset pools to fund. And one should not forget the biggest new issuers on the block: the European Financial Stability Fund (EFSF) and the EC, which have already priced large euro benchmarks in the first months of 2011 and will come back for more.
The euro market needs to accommodate these blockbuster trades and there is little attention for old market hands, especially when the newcomers tend to pay juicy premiums. Meanwhile, key sovereign trades like the Eu3bn 10 year for Portugal in mid-February tend to get all of the market focus and leave little room for anyone else.
Meanwhile, agencies that have existed for many years have seen their funding needs increase. For example Cades plans to raise Eu30bn-Eu35bn in 2011, a much bigger requirement than last years Eu13.8bn.
"We are seeing more frequent issuance by smaller agencies as their funding programmes increase," says Adrien de Naurois, director at Deutsche Bank. "This trend is likely to continue as central governments seek to lower their debt burdens and decentralise borrowing requirements. As a result, the number of issuers looking at the markets on a regular basis is likely to increase potentially creating more scope for bottlenecks or conflicts."
That the dollar market continues to offer attractive costs of funding as a result of the advantageous cross currency swap has helped with the continued appeal of the market. Issuers can in some cases save up to 50bp.
But for others, they will be there whatever the cost.
"In 2010, the overall share of dollars in our funding programme was 37% and it is the second most important currency just after the euro, which made up 41% of our total funding last year," says KfWs Eitel. "For us, it is really diversification rather than cost savings through the basis swaps which drives us to that market."
But for all of its advantages, the dollar market is not without its limitations, as shown by the effect of the sovereign crisis on some European supras and agencies in 2010.
"The sovereign crisis has impacted us, like it has every other borrower in Europe," says Eila Kreivi, head of funding for the Americas and Asia Pacific at the EIB. "The increased volatility affected us most in the second quarter of last year, but we were able to use alternative channels in orders to raise funds."
According to Dhawan, before the financial crisis, EIB issued at deep sub-Libor levels but its issuing levels now range from flat to 25bp between three and 10 years.
"The impact has been largely felt in dollars because of the wide dispersion of our investor base in dollars and the tendency for some of those to react more to exogenous headlines," he says. "That we have a more liquid curve also means that it is easier for investors to get out of, and into, our bonds."
But for certain issuers, it is not just a cost issue. Some have not had access for a long time. For example, the last time Spanish agency Ico launched a dollar benchmark deal was in March 2010, when it priced a $1bn three year bond. Since then, the issuer has had to rely on its domestic and wider euro investor bases to get deals away.
"We have seen the negative headlines limiting access for some issuers. Some of the peripheral names have been absent for over a year and the market is not as open as it was," says Arkus.
"For these issuers, the dollar market is not as conducive to issuance and the levels are not favourable. As well as wider spreads, it is a riskier market in terms of execution."But Arkus believes that these issuers will eventually be able to return to dollars. "As long as issuers are responsible and do the right thing, a deal should work."